Financing constraints and firm dynamics.

Abstract

How important are financing constraints in explaining the cyclical behaviour of investment. How do they affect the investment responses to macroeconomic shocks. This thesis answers these questions by developing a structural model of investment with financing and irreversibility constraints and by analysing its implications both theoretically and empirically. After briefly reviewing the recent advancements of the investment literature in chapter 1, in chapter 2 we present a preliminary empirical analysis of the links between financial structure and firm dynamics. In chapter 3 we develop a basic structural model which analyses optimal investment and saving choices of entrepreneurs in the presence of uncertainty as well as of financing constraints. We show that future expected financing constraints generate a precautionary saving behaviour which affects the optimal allocation between risky investment and saving. In chapter 4 we extend the basic model to include both fixed and variable capital as well as financing constraints and irreversibility of fixed capital. We show that the interactions between financing and irreversibility constraints amplify the effects of financing constraints on the cyclical fluctuations of investment and production. This interaction together with the precautionary saving behaviour is essential in explaining a number of stylised facts about investment dynamics: i) aggregate inventory investment is very volatile and procyclical, especially in recessions; ii) it leads the business cycle, while fixed capital investment lags it; iii) fixed and especially inventory investment are sensitive to net worth; iv) output and inventories are more volatile and procyclical for small firms than for large ones. In chapter 5 we verify empirically the theoretical results derived in chapter 4. We use our panel of balance sheet data on Italian manufacturing firms to test and not reject the financing constraints hypothesis. This hypothesis is also strongly supported by the direct qualitative information about the problems faced by the entrepreneurs in financing new investment projects.